125220_16(T8): FX Markets

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  1. Importance of FX markets
    • FX markets required for smooth functioning of international trade & transferring savings between countries
    • International capital markets transfer funds from surplus countries → deficit countries
  2. Exchange rates
    • Value of one currency relative to another currency
  3. FX markets - important history
    • 1944 - Bretton Woods = fixed exchange rates pegged against the US$ which was pegged against gold
    • 1973 - changed to floating (due to change trade patterns, economic growth)
  4. Fixed Exchange Rates
    • Value of currency determined by government or central bank.
    • Demand/supply of currency usually not in balance under this system, so govt has to use reserves if demand for foreign currency is greater than supply
  5. Fixed Exchange Rates - 1. "If too much pressure on overseas currency reserves..."
    Govt may be forced to devalue/put severe restrictions on movement of funds.
  6. Fixed Exchange Rates - 2. "If FC supply > demand..."
    Reduction may be necessary if the government begins to hold too many reserves.
  7. Floating Exchange Rates
    • An exchange rate is determined by supply and demand factors in the FX market
    • NZD floated March 1985

    If demand for $ increases, currency appreciates. If demand decreases, currency depreciates
  8. FX participants
    • Foreign exchange dealers and brokers
    • Central banks
    • Firms conducting intl trade transactions
    • Investors/Borrowers in intl money &/or capital market
    • Foreign Currency speculators
    • Arbitrageurs
  9. FX Markets - Location
    Global telecommunications network between major financial centres i.e. large banks - largest OTC market in NZ & globally
  10. FX Markets - Trading hours
    Around the clock, NZ niche time- after LA closes & before Sydney opens
  11. FX Markets - Most active centres
    UK most active FX centre 34.1%, US 19%, Japan 8%
  12. FX Markets - Deepest volume @...
    Deepest volume around midnight when NY & Europe trading ⇒ lowest bid-ask spreads
  13. FX Markets - Volume
    Global transactions averaged US $5.3T billion per day April 2013 with 1.5T spot FX
  14. FX Markets - Unique characteristics
    liquidity, trading vol., no. of traders, trading hours, low profit margins (bid-ask spreads) but overall profits may be high due to large volume & use of leverage
  15. Market  Segments & Instruments traded - Spot market
    For currency deals for immediate delivery/instruments with maturity date within 2 business days after transaction.
  16. Markets Segments & Instruments traded - "Tom", "Tod"
    • Tom - transactions settlement tomorrow
    • Tod - same-day settlement
  17. Markets Segments & Instruments traded - "forwards & forward swaps"
    Involves future delivery of currency at specified future date
  18. Markets Segments & Instruments traded - "Futures & Currency Options"
    Deals in contracts to hedge against future changes in FX rates
  19. Markets Segments & Instruments traded - "Swaps - currency swap"
    Technique that takes floating-rate debt servicing in one currency (coupon & principal repayments) & hedges the cost in terms of another currency.
  20. FX Basics - Asking For a Quotation - 'you may ask “What is SF NZD spot rate?”'
    • Dealer will know that you are asking for spot price of SF1 in terms of NZD
    • If you said NZD SF rate, quote will be for price of NZD1 in terms of SF
  21. First currency mentioned is the...
    Unit of quotation or base currency
  22. Two Number Quotations (Dealers) - "USD/NZD 1.5044 - 1.5061"
    USD/NZD one fifty forty four to sixty one. Note that decimal point is not mentioned & second number is abbreviated to 61
  23. Two Number Quotations (Dealers) - "Kiwi Euro is one-thirteen fifty-two to sixty-eight means"
    NZD/EUR 1.1352 - 1.1368
  24. Understanding Foreign Exchange Spot Quotes (bid price, ask price, spread)

                                Bid      Ask
    Quote: NZD/USD  0.6244  0.6251
    • FX dealer 'buys low' and 'sells high'
    • Bid price = buying price. Bank will buy NZD1 for USD 0.6244 (Customer view - sell NZD1, get USD 0.6244)
    • Ask (Offer) price = selling price. Bank will sell NZD1 for USD 0.6251 (Customer view - receive NZD1 on payment of USD 0.6251 to dealer)
    • Spread = difference for bank or dealer
  25. Quotes - "Commodity" vs. "Terms" - Commodity
    Usually one that is expressed as 1
  26. Quotes - "Commodity" vs. "Terms" - Term
    The other currency, one that varies in price
  27. Quotes - "So when the term’s currency in the quote..."
    • rises ⇒ commodity is dearer
    • falls ⇒ commodity has fallen in value
  28. E.g. 1 NZD = 0.4600 USD moves to 0.5000
    Rise (appreciation) in the Kiwi
  29. E.g. 1 NZD = 0.4600 USD moves to 0.4500
    Fall (depreciation) in the Kiwi
  30. Convention in the FX markets
    • Currently, all countries quote to the USD
    • Some use it as term’s currency (American) & some use it as commodity (European)
    • Commonwealth countries use USD as 'terms currency'
    • Other countries - USD 'commodity', express their value as 'terms'
  31. Convention in the FX markets - "direct" and "indirect"
    • Direct =  local currency price of 1 unit USD, where the USD is unit of the quotation or base currency 
    • Indirect = is the price of USD of one unit of home currency Where the USD is the terms currency & the other currency is base currency
  32. Reciprocals
    It is possible to reciprocate quotes & reverse the commodity currency to the term’s currency & vice versa.

    • Simply divide the quote into 1
    • 1 NZD = USD 0.5000
    • So 1 divided by 0.5000 or 1/0.5000
    • 1USD = NZD 2.000
  33. Reciprocals for 2-way quotes
    • Transpose
    • Reverse quote
    • Then, take reciprocal

    • NZD/EUR   1.2255 1.2265
    • Reverse     1.2265 1.2255
    • Reciprocal  0.8153 0.8160
  34. Cross Rates - Crossing two direct quotes -e.g. USD/EUR  0.89303 – 08 , USD/JPY  101.921 – 31
    • First: divide offer into bid
    • Second: divide bid into offer
    • Image Upload
  35. Cross rates - Crossing direct & an indirect FX quote

    GBP/USD   1.31352 – 57
    USD/NZD   1.38273 – 78
    Image Upload
  36. Cross rates - Crossing two indirect FX quotes

    AUD/USD  0.75566 – 73
    GBP/USD   1.31386 – 91
    Image Upload
  37. Forward transactions
    FX can be bought or sold for a price determined today but delivery takes place at a predetermined future date
  38. Conventions for quoting the outright forward rate - Example: Ask for spot & 1 month forward- given the Kiwi is fifty one thirty to forty, one -thirty- three to twenty- four
    • To determine whether to add/subtract forward points
    • - If ascending, then add to the spot rate
    • - If descending, then subtract from spot rate
  39. If forward points are falling...
    The commodity currency is at a forward discount
  40. If forward points are rising...
    The commodity currency is at a forward premium
  41. Conventions for quoting the outright forward rate - Example - Ask for spot & 1 month forward- given the Kiwi is fifty one thirty to forty, one -thirty- three to twenty- four
    Image Upload
Card Set:
125220_16(T8): FX Markets
2017-02-11 02:43:38
125220 16 T8

FX Markets
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